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Beware High-Speed Trading’s Hidden Cost

I was interviewed this morning about how to discuss the high-frequency trading controversy (on account of a new book by Michael Lewis and related publicity) with clients. The resulting article from ThinkAdvisor is available here. I hope you will read it. A quick snippit follows.

ThinkAdvisor: So in a sense, ordinary investors are barely harmed by this latest Wall Street scandal?

Seawright: That’s the insidious part of it. It’s not something that you readily see. You hit enter on your order and you get filled in part or filled at two different prices and the assumption always was, “Well, that’s where the market was.’

And the reality is that is where the market was, but the market was there because somebody stepped in between really, really fast.

For retail shops like ours it’s not a [significant] issue because our orders aren’t big enough that’s somebody’s going to step in front of them. If somebody’s buying 100 shares of something, there’s not enough money to be made stepping in front.

But when a client owns a mutual fund, and the mutual fund is trading shares, and somebody steps in front of that, it matters significantly to the portfolio as a whole, and by extension it matters to some extent to investors: 2 cents a share is a rounding error, and I get that.

On the other hand, the high-frequency trading firms are spending hundreds of millions of dollars to get another couple milliseconds of an advantage. Clearly it’s a real advantage to them, and that money’s coming from somewhere. That money is coming out of our clients, mutual fund clients and everybody else that’s involved in the market, and that ought to concern all of us.